How We're Structuring Fixed Income Exposure For Today's Market
Blog of HORAN Capital Advisors | Feb 05, 2013 01:52AM ET
Since mid November, interest rates have made a fairly strong move to the upside. Since the principal value of fixed investments moves inversely to rates, longer term fixed income investments have experienced principal declines. Recent treasury rate moves are noted as follows:
- 10-year treasury has increased to 2.01% (2/1) from 1.57 (11/16)
- 5-year treasury has increased to .87% (2/1) from .61 (11/16)
In many of our client accounts we have attempted to get in front of this rise in rates by structuring our fixed income portfolio in a barbell type approach by focusing on shorter maturity investments on the one hand and focusing on lower quality credit on the other. It should be noted that late last year we did trim our high yield exposure in client accounts overweighted in this segment of the fixed income market.
A couple of the short term investments we have utilized are Vanguard’s short term investment grade fund (VFSTX) and the iShares 1-3 year Credit Bond ETF (CSJ). We continue to like floating rate exposure and recently added to Fidelity's Floating Rate Fund (FFRHX). In a rising interest rate environment, floating rate investments should hold up better as the rates on the underlying fund investments adjust higher as rates rise. In the very short term, in a rapid spike higher in rates, the floating rate note principal can decline. In a gradual rise in rates that has occurred since late last year, the investments noted above, CSJ, VFSTX and FFRHX, have held up well and in fact have increased in value. Conversely, investments that have longer maturities, for example, Barclay’s Aggregate Bond Index (AGG) and 20-year Treasury Index (TLT) have both experienced principal declines from 2% to over 8% since mid November.
The other area we maintain exposure is to credit via a high yield bond fund: Principal High Yield Fund (PHYTX) and the floating rate fund, both credit sensitive. Both of these have done well on a relative basis since November. We are sensitive to the fact treasury rates are rising and this is forcing the spreads on high yield bonds to narrow to low levels. The last area of fixed income we have allocated fixed dollars is in global bonds which we continue to be cautiously optimistic about. The global bond investment we utilize for clients is the Templeton Global Total Return Fund (TTRZX).
The top three lines on the above chart are fixed investments held in our client accounts. These three investment have held up well in this increasing rate environment. The treasury investment (TLT) and aggregate bond investment (AGG) have performed decidedly worse in the short run. The lines display the performance since 11/16/2012. As we noted in our recent Investor Letter, as a firm, we favor equity over fixed income tactically and would look to increase equity allocations with an equity market pullback.
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